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Analysts point out flaws with Goldman Sachs congressional hearings

by Lauren Osen

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Daniel Sparks (L), a former partner who ran the mortgage department, Goldman Sachs Trader Josh Birnbaum (2nd L), Managing Director in the mortgage department at Goldman Sachs Michael Swenson (2nd R) and Fabrice Tourre (R), who is accused of fraud in a Securities and Exchange Commission lawsuit over a mortgage-linked investment, are sworn in to testify on Capitol Hill in Washington, DC, April 27, 2010, during a Senate Homeland and Secruity and Government Affairs Committee Permanent Subcommittee on Investigations. Jim Watson/AFP/Getty Images

This week's Goldman Sachs hearing isn’t the first walk of shame that prominent CEOs have made in front of congressional committees - it wasn’t that long ago that executives from the auto industry, insurance companies and energy firms were all dragged in front of Congress for a righteous grilling.

The latest two days of testimony given by the chief executive of Goldman Sachs and his various underlings makes for good drama. The fraud case brought by the SEC against Goldman could result in billions of dollars in fines – but nobody will go to jail and business could likely carry on as usual.

Vincent Reinhart, resident scholar at the American Enterprise Institute (AEI) for public policy research and a former director of division of the Division of Monetary Affairs of the Federal Reserve Board, isn't very impressed with the proceedings. "It was good theater. We had senators getting to say bad words, but more than anything they got to convey their constituents' anger," he told KPCC's Patt Morrison at the 2010 Milken Global Conference.

Reinhart and Bruce Tuckman, director of financial markets research at the Center for Financial Stability and a former qualitative research director for Lehman Brothers, regard this week's hearings more as a political act of smoke and mirrors, or a political football, rather than an impetus for effective reform.

This is in the midst of people's homes going down in value and a high unemployment rate. Companies like Goldman Sachs seem to be skirting the law, and to at least be on the wrong side of an ethical responsibility. Reinhardt asked, "Don't you think that's a good target for politicians to target the voters' anger but also to use as an impetus for legislation they feel compelled to get passed this term?"

He added, "They don't want to have to face the electorate without having done something substantive.

"There isn't any relevance between this theater and what we need for reform," said Reinhardt. "It's bait and switch."

Reinhardt sees the current story of Goldman Sachs as relevant, but being used incorrectly as a symbol for financial reform. He's critical of the tone of this week's congressional hearings, which he sees politicians using for political gain, rather than real reform. "It shouldn't be this pinata attitude, but 'what can we do to reform our system?'"

Even as a debate rages in Congress over how much more power to grant the Federal Reserve and other regulators to monitor and potentially break up troubled financial giants, critics claim the financial regulation overhaul legislation doesn’t go far enough to prevent the next market meltdown.

Both agree that the current legislation could have prevented today's financial crisis but that the FDIC was too reluctant to act. "We've had that regulation for a long time ... the FDIC can do it," said Reinhardt. The challenge for good financial reform legislation is to create something that could stand in and be binding for future Congresses.

Otherwise, "the whole thing is irrelevant," says Tuckman. Reinhardt added, "you want to put yourself in the situation of some future authority. Will that person be able to exercise that authority?" He argues it does no good to beef up regulatory legislation if a future FDIC remains too reluctant to wind down an institution with such a large footprint as Goldman Sachs.

"Our basic problem," Reinhardt says, "is we let financial institutions be too complicated ... that let them make their balance sheet unrepresentative of the risks they were taking."

"Even the managers at the very top can't run the firm," added Tuckman. "We had 200 regulators watching two companies [Fannie Mae & Freddie Mac] and they didn't get it."

Reinhardt has resolved, "The regulation path is not the path." What we need, he argues, is "more effective market discipline."

"We should be looking wherever possible to make balance sheets more representative of the risks firms take."

They stress striking a balance between careful regulation and not stymieing innovation, while both willingly admit that "innovation" is part of what got us into this mess. "Anytime you have macroeconomic security, people will push the envelope."